Financial Reporting Concepts

The Standard-Setting Environment

• Generally Accepted Accounting Principles (GAAP)

  • A set of rules and practices with substantial authoritative support that guide financial reporting.
  • Incorporates decisions about:
  • Types of financial information to disclose
  • Format of financial reports
  • Measurement of assets, liabilities, revenues, and expenses

• Standard-Setting Bodies

  • Securities and Exchange Commission (SEC)
  • Financial Accounting Standards Board (FASB)
  • Public Company Accounting Oversight Board (PCAOB)
  • International Accounting Standards Board (IASB)
  • Over 115 countries utilize International Financial Reporting Standards (IFRS).

Qualities of Useful Information

1. Relevance

   • Information is relevant if it impacts business decisions.
   • Characteristics include:
     • Predictive value: Helps forecast future outcomes
     • Confirmatory value: Validates or adjusts prior expectations
     • Materiality: An item is material if its omission or misstatement could influence decision-making.

2. Faithful Representation

   • Information must accurately depict what has occurred.
   • Criteria are:
     • Completeness: Excludes nothing significant
     • Neutrality: Free from bias
     • Free from material error

Enhancing Qualities of Useful Information

• Comparability
  • Facilitates evaluation across companies using similar accounting principles.
• Consistency
  • Use of the same accounting principles and methods year over year.
• Verifiability
  • Information can be corroborated by independent observers.
• Timeliness
  • Information must be available before its relevance diminishes.
• Understandability
  • Information must be clear and concise for reasonable interpretation.

Assumptions in Financial Reporting

1. Monetary Unit Assumption
   • Only items expressible in monetary terms are recorded, leading to exclusion of qualitative data (e.g., customer satisfaction).
2. Economic Entity Assumption
   • Each entity's financial activities must be recorded separately, ensuring clarity between personal and company transactions.
3. Periodicity Assumption
   • Business life can be divided into specific time intervals for reporting purposes.
4. Going Concern Assumption
   • Assumes ongoing operation indefinitely, barring evidence to the contrary.

Principles in Financial Reporting

1. Measurement Principles
   • Historical Cost Principle: Assets recorded at the price paid for them.
   • Fair Value Principle: Assets and liabilities reported at current market value.
2. Full Disclosure Principle
   • All relevant circumstances and events must be disclosed in financial statements.
3. Cost Constraint Principle
   • Weighing the costs of information against the benefits garnered by users from that information.

Key Concepts Review

• Concepts guiding FASB for accounting standards include:
  • Relevance, Faithful representation, Comparability, Consistency, Verifiability, Timeliness, Understandability, Materiality, Cost constraint, and the Assumptions (Monetary unit, Economic entity, Periodicity, Going concern).

Primary Criterion of Accounting Information

• The primary criterion is Usefulness for decision making.